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Imperial Brands - Struggles in vapour offset traditional tobacco

Nicholas Hyett | 5 November 2019 | A A A
Imperial Brands - Struggles in vapour offset traditional tobacco

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Imperial Brands Group Ordinary 10p

Sell: 1,842.50 | Buy: 1,843.50 | Change 21.50 (1.18%)
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Imperial Brands saw full year tobacco volumes fall 4.4%, but net revenue rise 2.2% at constant currency to £8bn. That reflects price increases and Next Generation Product (NGP) growth. Operating profits fell 2.4% to £3.7bn as increased investments in NGPs hit margins.

The dividend was increased by 10% to 206.6p per share.

The shares were broadly flat following the news.

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Our view

Tobacco shares aren't for everyone, and global tobacco volumes have been falling for decades.

However, smokers' willingness to pay ever higher prices mean tobacco giants have managed to protect their margins and grow dividends even as the smoking population dwindles. Crucially, the companies have almost always traded on relatively high dividend yields, allowing investors to reinvest at attractive rates.

The question is whether the trick can be repeated going forwards. That depends on companies harnessing the right blend of brands, geographical exposure, NGP technologies and balance sheet strength to keep the dividend engine ticking over.

The resignation of Imperial's longstanding CEO, Alison Cooper, means a shake-up is probably on the cards. But here's where things stand at the moment.

Firstly let's deal with Imperials big attraction, the 12% dividend yield. It will no longer be growing 10% a year, but the group has recently committed to a progressive (read growing) dividend, with surplus cash returned through share buybacks. Cash is something Imperial does well, with 95% of operating profits converting to operating cash and ultimately being available for management to distribute or invest as they see fit.

Imperial's brand portfolio gives it commanding positions in several European markets and an attractive opportunity as an insurgent player in the US. Its positions in developed markets means it doesn't have the same exposure to rising populations and economic growth in emerging markets as some peers.

However, cigarettes are still relatively affordable in several of Imperial's key markets, such as the US, so prices could still have some way to go. Meanwhile, management has been improving efficiency in priority markets by moving smokers onto a smaller number of global brands.

Next Generation Products (NGPs) offer a potential path to growth, and Imperial has primarily invested in vapour via blu. A lot's riding on the reduced harm claims though. A recent spate of health scares have hit the US market already, although Public Health England is still recommending vaping over smoking.

Imperial's carrying about 3x net debt to underlying cash profits, which is higher than we might like, but not prohibitive for a company with such dependable earnings.

Finally, as Imperial is the smallest of the four tobacco giants there's a possibility they'll get bought out by one of the bigger players. This isn't guaranteed though - and competition regulators may prove a major hurdle given current market concentration.

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Full Year Results

Tobacco revenue rose 1.1% to £7.7bn as the group continued to offset volume declines with higher prices. NGP revenue rose 48.1% globally to £285m, which was behind the group's original expectations, though more in line with recent updates.

In Europe tobacco volumes fell 4.4%, while revenue rose 0.8%, reflecting stronger pricing. European NGP markets have not shifted to the "pod" model as quickly as Imperial had anticipated, and growth was slower than hoped for. Investments in NGPs offset revenue gains for a 0.3% fall in operating profits.

In the Americas a strong tobacco performance led by mass market cigars saw underlying volumes fall 5.3% but revenue rise 6.8% to £2.4bn. However, on the back of regulatory uncertainty and health concerns, NGP revenue declined 30.5%. Again, the high level of investment in NGPs saw operating profit fall 2.6% to £1.1bn.

Tougher trading in the Africa, Asia and Australasia division saw tobacco volumes fall 5.0% and revenue fall 4.8%. The fall in tobacco revenue was led by declines in Russia, Australia and the Middle East, which led to operating profit falling 8.1%.

Reported operating profit and earnings per share figures were negatively impacted by large write downs in the value of the group's intangible assets - particularly related to the Premium Cigar Division, which the group intends to sell.

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The author holds shares in Imperial Brands.

This article has been amended to correct the net debt to EBITDA ratio.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.